In a bid to cool the UK’s booming property market the Bank of England has recommended that lenders introduce new affordability checks linked to potential interest rate rises and limit the amount of higher risk loans offered.

In its Financial Stability Report, published this morning, governor Mark Carney recommended that lenders, stress-testing a borrower’s ability to repay their mortgage if interest rates were to increase by 3% from the time they took out the loan. In addition banks should also have a maximum of 15% of residential mortgages on their books where the amount borrowed is at or greater than, 4.5 times income.

Lenders are however already using tougher affordability checks as a result of new regulations introduced in April by the City regulator, the Financial Conduct Authority, known as the Mortgage Market Review (MMR).

In its report, the Bank of England Financial Policy Committee (FPC) stated: “The recovery in the UK housing market has been associated with a marked rise in the share of mortgages extended at high loan to income multiples. At higher levels of indebtedness, households are more likely to encounter payment difficulties in the face of shocks to income and interest rates. This could pose direct risks to the resilience of the UK banking system, and indirect risks via its impact on economic stability. The FPC does not believe that household indebtedness poses an imminent threat to stability. But it has agreed that it is prudent to insure against the risk of a marked loosening in underwriting standards and a further significant rise in the number of highly indebted households.”

Bank of England governor Mark Carney

At the press conference Carney tempered the measures, he said: “If yesterday you went into a bank or building society and were approved for a mortgage, you will still be approved for that mortgage today,” adding you “can have more confidence in the durability of the expansion.”

While Carney urged that the FPC does not believe that household indebtedness poses an imminent threat to stability, he said: “Prospects for household indebtedness concern us. Although UK households have made progress in repairing their balance sheets, they start from a vulnerable position, with debt at 140% of their disposable income. The share of mortgage lending at high loan-to-income ratios has increased markedly over the past year to a record high. Given the momentum in the housing market, and the underlying shortage of housing supply, it is likely that this trend will continue.”

– When assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, Bank Rate were to be three percentage points higher than the prevailing rate at origination.

– The Prudential Regulation Authority and the Financial Conduct Authority should ensure that mortgage lenders limit the proportion of mortgages at loan to income multiples of 4.5 and above to no more than 15% of their new mortgages.

The latest official figures show there was an annual property price increase of 18.7% in London, while excluding London and the South East, property prices were 6.3% higher in April than 12 months before according to the Office for National Statistics.

Speaking to the BBC, Chancellor George Osborne said he backs the BoE’s move to put a cap on high loan-to-income mortgages. “I fully support this action by the Bank of England’s new Financial Policy Committee to use the new powers we have given them,” he said. Osborne also added that he would apply the new mortgage limits to every loan in the government’s Help to Buy mortgage programme.

Ben Brettell, senior economist at financial adviser Hargreaves Lansdown believes that many will argue today’s measures don’t go far enough and that its looks more likely that interest rates will be kept where they are for longer.

He said: “Mark Carney stressed that if someone could get a mortgage yesterday they could get one today. However, the fact that the FPC has at least taken some steps to limit future excesses in the mortgage market is a welcome development – ever-increasing household debt levels would certainly pose a threat to financial stability.”

He add however that the specific action on the housing market gives the Monetary Policy Committee more freedom to leave interest rates where they are.

He said: “There have been calls for higher interest rates to prevent house prices rising too quickly. In my view this would be a blunt instrument – the effects would be felt across the economy, not just in the housing market, and the evidence suggests the wider economy is not yet strong enough to withstand a rate rise. Wage inflation remains subdued, and the falling unemployment figures mask a fall in productivity. It therefore seems fair to assume that a significant degree of slack in the labour market remains.

“Therefore despite Mark Carney’s recent comments that interest rates could rise sooner than expected, I believe they will remain on hold well into next year. The Bank will want to give today’s measure on the housing market time to take effect, and will want to see hard evidence that the spare capacity in the labour market has been absorbed before considering higher interest rates.”

“…many will argue today’s measures don’t go far enough and that its looks
more likely that interest rates will be kept where they are for longer.”

You can say that again!! The limit should be 3.5 times income with no more than 80% loan to value. Detailed guidance on affordability calculations re interest rate rises need to be provided, like assumptions of an average 3% pa inflation alongside 1.5% pa wage rises over 5 years and then they will be approaching realistic projections.